Bank Analyst: Mortgage Lawsuit May Hurt Housing Recovery

A decision by the Federal Housing Finance Agency to sue 17 banks on grounds they misled the agency on the quality of mortgage securities they sold it could ultimately hurt the housing sector's recovery, says Paul Miller, managing director at FBR Capital Markets.

"It does drain valuable capital away from the space and ... it makes the banks reluctant to loosen up the credit standards," Miller tells CNBC.

"Therefore, you're cutting off credit to borrowers who want to buy homes, so yes, it is having a negative impact out there on the housing market."

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That's not good for the overall economy, as it could help tip an already weak housing sector back into negative territory.

"We are coming upon a double dip in housing because we're not able to give credit to people who want to buy homes," Miller says.

The FHFA sued a number of major banks last week over losses on more than $41 billion in subprime mortgage bonds, which may hamper a broader government mortgage settlement with banks.

The lawsuits by the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, could add billions of dollars to the banks' potential costs at perhaps the worst possible time for the industry.

The FHFA accused major banks, including Bank of America, its Merrill Lynch unit, Barclays, Citigroup and Nomura Holdings of selling bonds backed by mortgages that should have never been packaged into securities.

"The loans had different and more risky characteristics than the descriptions contained in the marketing and sales materials provided to the enterprises for those securities," the FHFA says in a statement, Bloomberg reports.

The biggest banks are already negotiating with the attorneys general of all 50 states to address mortgage abuses. They are looking for a comprehensive settlement that will protect them from future litigation and limit their potential mortgage litigation losses.

"This new litigation could disrupt the AG settlement," said Anthony Sanders, finance professor at George Mason University and a former mortgage bond strategist.

Banks may be more reluctant to agree to a settlement if they know litigation from other government players could still wallop their capital, he told Reuters.

"However, we believe that the defendants have strong defenses that could result in litigations stretching out for a significant length of time. As a result, we would expect the most likely scenario to be a settlement between the mortgage originators and the FHFA for a much smaller amount," MarketWatch reported the Keefe analysts said.